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Crony Capitalism and Public Sector Banks of India

Capitalism basic tenet says the state should follow laissez-faire policies i.e. should allow private initiatives unhindered without regulations. This in turn would allow ‘invisible’ hand of market of self-regulation which would through competition generate greater good. Since its propounding by Adam Smith in 18th century, this policy has attracted derision and criticism primarily from moral thinkers and plebian poor. First serious challenge mounted by advent of communism was blunted and defeated by evolution of laissez-faire into welfare state to some extent and failure of state controlled economy and censored society. Today capitalism faces an enemy from within which seeks to subvert the basic tenet of it – the free market.

In India today to become an industrialist you do not need to bring your capital or technology which is required under capitalism but only be well connected. Company’s law which brought in concept of limited liability in India has been subverted by promoters to something grotesque and it has been commented by none other than RBI Governor Raghuram Rajan that India has poor companies and rich promoters. Today markets are roiled by news that public sector banks in India have written off approximately Rs1.14 lakh crore as NPA which had been advanced to Corporates in last few years. This will write off will further balloon by approximately Rs. 52,000 crore this year. This massive write off which has resulted in wipeout of value in public sector banks on stock exchanges represents massive loss to the taxpayers that is us. Currently all public sector banks share trade below price to book value ratio of 1, that is, their market capitalization is less than their assets! In comparison Indian private sector banks are trading at significant premium.

So if we believe markets as is the tenet of capitalism then this shows there is fundamental problem in governance of public sector banks. Public Sector Banks have served laudatory purpose in past and carry disproportionate weight of delivering public goods through extension of social financial extension schemes latest being Jan DhanYojana, and Insurance schemes of government of India. Government India remains majority shareholder in all public sector banks this shareholding looms large on their functioning. Biggest burden on public sector banks is political influence in their basic activity – disbursement of loans. Hence connected industrialists like Dr. Vijay Mallaya (who has been declared willful defaulter now but hardly any action has been taken against him) can raise thousands of crore on dodgy business models and little collateral, which when turn bad blame gets on banks in turn destroying wealth and jobs.

As a cruel reminder of crony capitalism existing in India, more than Rs. 42.6 lakh crores has been given to corporates as ‘revenue forgone’ in form tax exemptions by government of India in last 10 years alone. Compare this with figure of much maligned debt waiver of farmers in 2008 which was estimated to be at Rs. 71,000 crores. Due to back to back droughts thousands of farmers have committed suicide in country. And due to this ‘rural distress’ and global economic headwinds, corporate are claiming that they are unable to service their debts which were taken in first place by political influence. So failure of corporates are being borne by public sector banks whose cost ultimately India public will pay while at the same time using limited liability clause the promoters who many times embezzled money from own company or awarded themselves huge compensation are making merry.

In another example of gross injustice is – recently Haryana and Rajasthan enacted laws which put up criteria of basic educational criteria and others significantly it also has criteria of farmers contesting panchayat elections not to be defaulters. While concern for cooperative banks who are major lenders to agriculture sector is laudable but it makes one wonder how major industrialists whose companies are on verge of default are nominated to RajyaSabha!

To paraphrase RBI Governor Rajan – ‘saving capitalism from capitalist’ we need to evolve a mechanism to put in place adequate reward and punishment mechanism for risks borne. Currently the system is too rigged towards crony capitalist, who reap all gains if the risk pays off while public sector banks are saddled with NPAs if business goes south. To implement such a mechanism, government needs to do away with blanket tax protection for interest on debt taken by companies. It only encourages corporates to leverage their balance sheet more and more. This results in debt overhang and in downturn increase in stressed assets. This blanket tax protection also encourages risky decision being taken where debts fuel corporates ambitious plans while promoters put very little of their own money. This mechanism should be modified fromcomplete blanket protection to giving tax protection only till say leverage of 0.5 is reached (equal debt and equity in company) to retain owner’s skin in the business and after this tax protection on interest payment reduces with increasing leverage.

Spate of governance reforms is required like making public sector banks autonomous in decision making ability. While this has been agreed many times in principle, latest in Indradhanush plan by NDA government but till government of India remains majority shareholder directly the influence of ministry would always loom large on public sector banks. In this scenario recommendation of Nayak Committee which recommended formation of Bank Holding Company to hold all banking stock of government of India should be implemented. Recently Deputy Governor of RBI Mr. Gandhi gave statement that public sector banks should be freed from their public responsibility this would increase the market value of government of India’s stock which in turn would lead to greater funds availability for it for social welfare schemes.

Eliminating crony capitalism is critical in restoring public faith in institutions and hope that hard work and perseverance will pay off in better social and economic mobility for them. If crony capitalism persist it would not only destroy capitalism but also distort the very fabric of society leading to rpe condition for violent revolution. The inequality index is worsening in India in tandem with world with rich getting richer and poor getting poorer. In one of the steps in fight against such system, reforming public sector banks governance will be a valuable contribution. But question remains will government limit itself and implement these reforms in public sector banks.